“You’re in the cinema, thirty minutes into a film you don’t like. There’s over an hour left to go. Do you stay or do you leave?”
“Hands up if you’d stay.”
Around 80% of the class raised their hand.
“Hands up to leave.”
The remaining 20% raised their hand.
“Why would you stay?”
A reluctant volunteer piped up to respond; “I’ve already paid for the ticket and invested time to get here. Plus, I have no other plans.”
“Why would you leave?”
“I could make better use of my time,” another student answered.
80% of a class of over 300 students fell victim to the sunk cost fallacy. The same fallacy considered to be one of the top 20 reasons why startups fail.If you’re an entrepreneur and you’re not familiar with the term “sunk costs”, you may have a problem. Sunk costs are all the irrecoverable costs that you’ve already spent. It’s money you’ll never get back regardless of what you choose to do, and it’s for this reason that they shouldn’t be factored into future decisions. They’re irrelevant.Take a manufacturing business for example. The founders buy a non-refundable machine that costs $250,000 dollars. Once they do, they realize the cost to produce each item outweighs the return they expect to receive. The rational course of action would be to not produce; their initial idea isn’t viable. It’s a shame they realized this after they bought the machine, but that’s neither here nor there.
The difficulty with making rational business decisions is humans aren’t rational; entrepreneurs and businesspeople included. We’re subject to biases that lead us to make irrational decisions. We power through to avoid our previous efforts ‘being in vain’, or ‘going to waste’. We’re guided by emotions. And the more we invest, the more attached we become to our ideas, our decisions, and the resources we’ve already incurred.We do this all the time. We get our money’s worth in restaurants by finishing colossal portions of food, we sit through films we dislike, and we wear shoes that give us blisters because we already spent $400 on them. These may be poor choices, but they’re not major problems. Falling victim to the sunk cost fallacy in business, however, could and often does, lead to ultimate failure.
We saw it happen to the UK’s HMV music company. By 2008, it was running a global network of over 600 outlets. As early as 2002, an advertising agency’s warning of the pending dangers of downloadable music was met by an angry response from then Managing Director Steve Knott, who said: “downloadable music is just a fad.” It was too little too late by the time the company opened its first digital music store in 2010. It went into receivership in 2013.
Their grip on the past was too firm, so much so that these leadership teams failed to take action. They sat in their seat and endured the whole film; up until the credits (and their creditors).
This topic came up in conversation with Heather Stupi; co-founder of Reposite, a workplace tool for travel and events professionals. My sister and I were eager to share her story on our podcast, since she and her two co-founders, Alexa Beube and Jaime Getto, managed to completely reinvent their startup at the outset of covid-19.
Nowaday welcomed excited tourists with “the city’s only 1920s era car tour”. It gave them a unique sightseeing experience through Manhattan’s most iconic sites, in fully restored classic cars. They announced the launch publicly in November 2019, at a party attended by the likes of Drew Barrymore and Miss J. Alexander, icons that reflected the company’s ethos of having “a roaring good time”.
It gave them the momentum they needed and Nowaday immediately took off. The trio was met with huge demand in January and February 2020; a demand they expected would only grow during the spring and summer months. But it didn’t.
The young startup began to feel the ripple effect of covid-19 during the first three days of March. At this stage, nobody could have predicted the impact the pandemic would have, and the young co-founders didn’t take it seriously. But roughly 5 days after that, their clients began to request refunds in the masses.
By this point, they had spent a year’s worth of their time and efforts on Nowaday. They had widely promoted the brand, sourced significant amounts of money from investors, they had even purchased cars and built strong relationships with distribution channels. It would have been understandable had they chosen to wait. Nowaday was their baby; they didn’t want their efforts to go to waste. Plus, what would they do with a collection of 1920s cars?
But it also became obvious they couldn’t just “wait and see”. The company relied on momentum, and with the outbreak of covid-19, they lost it. They had two options. They could let their emotions guide them and hold on to Nowaday; avoid those sunk costs going to waste. Or, they could be rational and look to the future. They chose the latter. The trio unanimously decided to pivot and completely reinvent themselves.
It didn’t take long for them to come up with a new idea they could pitch to their investors and keep hold of their funds.
Reflecting back on their experience at Nowaday, they identified a huge untapped need in the trillion-dollar global travel industry. Building strong relationships with their distribution channels had been a key contributor to their success. In working with these stakeholders, they had identified a gap in the market. A huge one in fact. The travel agencies they had been working with were relying on outdated resources and had no online tools or holistic platforms on which to manage their business.
Over the coming days, the trio lined up back-to-back calls with various stakeholders in the industry. They asked them to share their screens so they could better understand their operations and identify common pain points. Equipped with this new information, the talented co-founders came up with a solution.
Since the travel industry was on an indefinite pause, they saw a perfect opportunity to develop a system that would help these entities recover once the time was right. They completely reinvented themselves, and are now successfully running Reposite, for which they have managed to source over $2.7 million from investors.
These young entrepreneurs saw the opportunity to pivot and took it; despite their former wholehearted dedication to Nowaday.
I asked Heather the cinema question. She replied:
“I leave…it’s my time!”
She explained how, in moments like these, she asks herself: “what’s the next best thing I can do?”
“What’s the best decision we can make right now that will get us to where we wanna go? The pivot for the business was just the same way. I could have spent a week lamenting about what could have been, and ‘oh we raised all this money for this incredible experience company’, we put so much into it. But that’s not the best thing I could be thinking about in that moment” — Heather Stupi
Inevitably, as all moments do, conflicting scenarios pass. You can either choose to wallow in despair and focus on the past (i.e. your sunk costs; the time and resources you’ve already invested), or you can focus on moving forward, by doing the next best thing.
Granted, there’s often an array of data to consider when one makes decisions in business. The solution isn’t necessarily clear-cut. But ultimately, decision-making is still decision-making; in any context. The same biases apply. This means it’s something that entrepreneurs, businesspeople, and in fact, everyone can work on by paying attention to how they face smaller decisions day-to-day.
It’s our emotions that make us irrational. It’s easy to let them guide our behavior, especially when we don’t make a conscious effort to recognize and address them. But they are possible to control ifwe do make a conscious effort to do so.
We need to consider: are our emotions tied to a sunk cost? Because taking a moment to think about whether it’s rational to hold on to what we’re holding onto, could be the first step towards doing the ‘next best thing’.